In a move to mitigate volatility in lesser-market-cap stocks, the SEBI and exchanges introduced an Enhanced Surveillance Mechanism for micro-small companies with a market cap of under ₹500 crores.
In a progressive step aimed at curbing extreme volatility in smaller-market-cap companies, the Securities and Exchange Board of India (SEBI), along with leading exchanges, has put forth an Enhanced Surveillance Mechanism (ESM) for companies possessing a market capitalisation of less than ₹500 crores. This ESM framework, set to come into effect from June 5, 2023, will ensure better monitoring and control over price variations in smaller stocks, thereby mitigating the risk factors for investors.
The ESM Framework
Inclusion and Exclusion Criteria
In a noteworthy announcement, public sector enterprises and public sector banks will be exempted from the process of shortlisting securities under ESM. This move is reflective of the inherent stability these sectors exhibit due to the direct involvement and backing of the government.
The ESM framework will primarily target securities exhibiting high-low price variation and close-to-close price variation. The criteria for entry will require the security to maintain a 100% margin from the settlement cycle of the trade date plus two days (T+2).
Trading Mechanisms and Reviews
Trading for selected securities will be settled through a trade-for-trade mechanism with a price band of 5% or 2% (if the scrip is already in the 2% band). The ESM also enforces weekly periodic call auctions for stocks that are already in Stage I of the framework. These stocks will maintain a price band of 2%.
The framework will implement a stage-wise review of securities on a weekly basis. Once a security has been a part of the ESM framework for a minimum of 90 calendar days, it will be eligible for stage-wise exit if it no longer meets the entry criteria.
Anticipated Impact
This introduction of the ESM for micro-small companies represents a profound shift in the market regulation landscape. This could prove to be a game-changer in terms of controlling abnormal price fluctuations in lesser-market-cap companies.
Last month, SEBI released a consultation paper suggesting the formulation of price bands for futures and options trading scrips. This move was proposed to enhance volatility management and minimise information asymmetry, thus creating a more transparent and reliable trading environment.
SEBI’s proposal to suspend trading for an hour if the price of any stock rises or falls by 10% in a single session, as opposed to the current 15-minute cooling-off period, indicates a forward-thinking approach towards market volatility management.
Reflection on Recent Events
This development comes at a significant time when the market witnessed the free-fall of Adani Group stocks following allegations of stock market manipulation by a U.S. short-seller. The ESM, once implemented, will be a robust tool to prevent such sudden market movements.
Additionally, the consultation paper also proposed the establishment of adequate surveillance and internal control systems, termed the ‘Institutional Mechanism’, by Asset Management Companies (AMCs). This move was proposed as a deterrence to potential market abuse and fraudulent transactions, such as the recent front-running cases involving individuals and entities, including Axis Mutual Fund’s former manager and the Life Insurance Corporation (LIC).
In conclusion, the introduction of the ESM by SEBI and exchanges is a significant step towards safeguarding the interests of investors in micro-small companies. Controlling the volatility in these stocks not only protects investors but also boosts overall confidence in the Indian stock market.